IFF Receives Approval for Dupont’s N&B Business: Waiting for the Right Entry Point $IFF

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When I first heard that IFF was buying Dupont’s Nutrition and Biosciences business, I gagged. I had known IFF from my time covering chemicals and knew it as a “secret SAAS business”, if you will.

For example, IFF provides scents and fragrances to perfume manufacturers. I like luxury brands, given “secular growth”, and IFF seems like an excellent “pick-and-shovel” play. In other words, I don’t have to pick the perfume that is going to win, I can just pick the underlying technology that should grow as the rest of the markets grow. A rising tide can lift all boats.

That’s not all IFF does – it also makes fragrances for household goods, detergents, and makes flavors as well. IFF used to be split ~50/50% between Flavors and Fragrances. IFF acquired Frutarom, which specialized more in the “natural” taste and scent market and also catered to small-to-mid sized companies, which also seemed to be a longer-term growth story (though in my view, this is really a GDP-ish business. I’d be buying for the stability + high ROIC).

I do view the ROIC here as “best-in-class” and like that IFF still seems underappreciated by the market. This isn’t a Sherwin Williams or something that is discussed everyday (yet).

As you can see below, to me, IFF had the “sexier” product portfolio as opposed to N&B.

I say this coming from experience covering Ashland. Ashland is a chemical producer that can be described as “specialty” (as opposed to “commodity”). Typically, this means high margins, limited capital intensity, lower volumes, and limited exposure to raw material changes like some commodities (e.g. ethylene).

But Ashland always had SOMETHING go wrong. They would spend several quarters talking about how great their personal care business is, and then next thing you know the profitability in that segment gets whacked and they’d have a big miss. And it turns out that Ashland’s components are certainly lower volume, higher margin business – but it is still highly competitive and subject to price cycles much like commodities are.

IFF’s core portfolio, especially fragrance, struck me as the better business. I recognize many of the Ashland constituents within the former Dupont’s business (cellulosics, guar). This is also clear through looking at gross margins (though not a perfect analysis), IFF’s historically 45% GMs compare to N&B with 36%.

That being said, from what I could glean from the proxy, N&B ROIC was still very good (they did ~$1.4BN of EBITDA on $3.6BN of tangible capital). N&B + IFF will also be way more diversified so a guar gum collapse wouldn’t kill them.

And that got me thinking that this deal could be much better than I expected. After all, N&B competes with Chr. Hansen (a beloved stock in the “compounder bro” universe) and it trades at 26.5x 2022 EBITDA at the time of writing… Chr. Hansen is a niche producer, though. N&B + IFF isn’t, so your company profile is “diluted” if you will… but scale matters too.

IFF & N&B just received approval to merge (its be a long, drawn-out process to get all the approvals). About a year ago in December 2019, the two announced they would be merging via a Reverse Morris Trust in a transaction that valued Dupont’s N&B business at 18.4x  2019 EBITDA, or 15.2x post synergies. This is a high multiple, but when you think about Chr. Hansen, the ROIC these businesses earn, and also think about the synergies between the two businesses, it makes sense.

While I like the business, the tough part will be integration. This is a massive transaction and sometimes analysts on Wall Street forget that pushing two huge companies together isn’t as easy as it looks on paper.  As I noted above, these companies kinda  operate in similar markets, but not really.

The interesting thing about the long, drawn out process is that the combined company has had to put out S-4s (which detail everything about the merger) along the way. We just got another S-4 on December 22, 2020. Unfortunately, both companies have reduced what they were expecting for 2021+ EBITDA. I don’t typically put much faith in these proxy projections anyway because they are typically inflated to get a deal done. In this case, I’d trust it more now that its come down and 2021 is closer to reality from a timing perspective.

IFF already had issues integrated Frutarom (and the latter had a bribery issue that had to be addressed), so it does concern me that they want to do a big deal again.  To emphasize the point, my take from the proxy was the IFF would do anything to acquire N&B. It just wanted to make sure it was the winner. That typically doesn’t work out well…

The concern is that N&B and IFF will be so distracted merging, that competitors can emerge and take share. This would not surprise me in the slightest.

The company will also be ~4.0x levered, which the market typically hates even if you’re a good business  (footnote: I don’t hate this).

The set-up here seems attractive… to wait for a better day. Right now, the stock is pretty richly valued. Results are coming down. And while this is a high ROIC business, I think there are too many “hiccups” post-merger that can come out and drive the stock down.

I say all this as a means of preparation for that buying day. I will be watching this one patiently for a good entry point.



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